ETF Investors Are Going International

Six of the top-10 ETFs for year-to-date inflows have been in international developed markets.

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When you look at the annual inflows of assets into ETFs, it comes as no surprise that equity-related funds have won the most money. Domestic markets have been on fire this year with the SPDR S&P 500 ETF (NYSEARCA:SPY) posting a total return of over 30% in 2013. That stellar performance has helped fuel more than $16 billion of net new dollars into SPY over the last 12 months. Clearly investors are betting on a continuation of the rally into 2014 with the expectation of further gains in US stocks. However, a closer look a list of the top-10 ETFs that gained the most assets in 2013 shows that international developed markets received the lion's share of new money this year.

According to Index Universe, international ETFs have accounted for six of the top-10 funds with the greatest year-to-date inflows. That translates into a net gain of over $40 billion in international markets compared to less than $38 billion in domestic stocks. This list (sorted by new assets) includes:

One of the bright spots for international stocks is that they haven't had the same huge move that domestic equities experienced in 2013. From a relative standpoint, they are a more attractive investment based on valuation and price metrics, which may factor into the argument for additional inflows next year. In addition, many international dividend-paying stocks are offering much larger yields than their domestic counterparts.

With the recovery in Europe firmly taking hold and a Japanese administration committed to stimulation through quantitative easing, the outlook for developed markets appears much stronger than emerging or frontier countries. In fact, emerging markets have languished in the red all year with both the iShares MSCI Emerging Market ETF (NYSEARCA:EEM) and the Vanguard FTSE Emerging Market ETF (NYSEARCA:VWO) making their way into the top-five ETFs for total outflows.

Currency trends can also play a factor in international investing as well. Recently the US dollar has fallen precipitously, which has translated into strength in the euro and other developed currencies. That may be helping to support European asset prices in the near term. By contrast, Japan has been working on a coordinated effort to stimulate inflation, which has devalued its currency in the hope it will attract additional foreign capital. So far the results seem to be working.

My personal belief is that we are going to see more strength in international stocks or companies with significant overseas sales moving forward as investors rotate into pockets of value. In addition, I would not be surprised to see emerging markets buck the trend of underperformance and begin to narrow the gap with the rest of the world. With the caveat that we don't experience a global meltdown in 2014, the outlook for these markets seems to be steadily improving.

My advice is to consider adding to your international positions with the understanding that they tend to be more volatile than domestic equities. Remember to use a stop loss or other risk management approach to mitigate the effects of a steep correction.

Read more from David Fabian, Managing Partner at FMD Capital Management: